Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries

Abstract

We propose and solve a small-scale New-Keynesian model with Markov sunspot shocks that move the economy between a targeted-inflation regime and a deflation regime and fit it to data from the U.S. and Japan. For the U.S. we find that adverse demand shocks have moved the economy to the zero lower bound (ZLB) in 2009 and an expansive monetary policy has kept it there subsequently. In contrast, Japan has experienced a switch to the deflation regime in 1999 and remained there since then, except for a short period. The two scenarios have drastically different implications for macroeconomic policies. Fiscal multipliers are about 20% smaller in the deflationary regime, despite the economy remaining at the ZLB. While a commitment by the central bank to keep rates near the ZLB doubles the fiscal multipliers in the targeted-inflation regime (U.S.), it has no effect in the deflation regime (Japan).

The Zero Lower Bound and Endogenous Uncertainty

“…One exception is Aruoba et al . () but they do not find evidence that the US switched to the deflationary equilibrium following the Great Recession.…”

Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence From the Lab

“…Formally, we follow the empirical approach of Aruoba, Cuba-Borda, and Schorfheide (2018) and compute the multiplier Besides ensuring independent observations, the two scenarios are subject to the same expectational shocks (either triggered by initial pessimism or the display of bad news).…”

“…The dangers of relying on linear approximations to study liquidity trap dynamics are documented, for example, in Maliar and Maliar (2015), Fernández-Villaverde et al (2015), Braun, Korber, and Waki (2012) and Aruoba, Cuba-Borda, and Schorfheide (2018). We compare the experimental economies under this treatment with a second, policy mix treatment.…”

Review of Solution and Estimation Methods for Nonlinear Dynamic Stochastic General Equilibrium Models with the Zero Lower Bound

“…To deal with this issue, we adapt an index function approach to the solution methods as in Aruoba et al . (), Gust et al . (), Hirose and Sunakawa () and Nakata ().…”

“…Aruoba et al . () merge the EDS grid with the observed data points. This augmented grid covers some regions in the state space that the endogenous dynamics of the model scarcely explain and improves the fit of the model to the data.…”